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Ezrati's Economic Outlook: The President's Budget

Plan is DOA, but what’s not in it is most revealing.

President Barack Obama has released his fiscal 2013 budget. Republicans promptly condemned it as irresponsible and merely a campaign document. Since Republicans dominate the House of Representatives, there is little chance that this budget, or anything like it, will pass into law before the November elections, if then. But if this proposed budget is dead on arrival, leaving little reason for investors to adjust their portfolios for it, still the document can instruct, especially on what it ultimately will take to address this nation’s deficit and debt problems. Two matters in particular come clear: (1) overall spending control demands entitlements reform and (2) tax hikes on the wealthy, whatever they mean to fairness, cannot fully answer the deficit question.

There is no need to dwell on detail to see the way to overall spending control. This White House budget has done what it can outside of entitlements, and the result has made it clear that such a focus is insufficient. The White House budget would cut defense outlays for 2012 and permit so little growth over the following four years that, overall, such spending would increase at a meager 0.8% a year from 2011 to 2016. In addition, the administration plans significant long-term cuts in non-defense discretionary spending. According to these proposals, such outlays would drop more than 8% during these five years, 1.7% a year. And yet, because this budget does little to address the growth in Social Security, Medicare and Medicaid, overall outlays—even apart from the interest expense on the debt—continue to grow at an annual rate of more than 4% over this time.

The problem with this neglect of entitlements spending is obvious in the changing budget mix projected by the White House. Social Security is budgeted to rise at a 5.4% annual rate during this five-year stretch, Medicaid at a 9.3% rate, and Medicare, where the president’s message at least alluded to cost controls, at a 4.3% rate. The overall increase in these programs exceeds the entire growth of federal outlays (excluding interest expense) by some 30%. These entitlement programs expand from 41.8% of the budget (again, excluding interest expenses) in fiscal 2011 to just under 50% by 2016. They clearly are the story. Without a direct consideration of entitlement cuts, there can be no substantive spending control, even, as this budget shows, with severe constraints elsewhere.

The president would beef up future federal revenues principally through two proposals. One is to reverse the Bush tax cuts on individuals earning more than $200,000 a year and couples earning more than $250,000. This proposal, of course, has been a high priority for Obama since the 2008 campaign. In this budget, he has also proposed an increase in the tax on dividend income for such wealthy people to 39.6%, from 15% currently. The second proposal is a version of what is called the “Buffett Rule.” It would replace the alternative minimum tax with a 30% minimum tax on all individuals who make more than $1 million a year, regardless of the income source.

Far-reaching as such plans might appear, the administration’s own figures show how little relative difference such tax hikes make in the overall budget picture. The White House projects an $809 billion additional overall revenue inflow from individual income. But more than one-third of this addition, some $300 billion, comes not from the tax changes but from the White House’s assumption that a rather robust economy will accelerate personal income growth. This budget, for instance, assumes real economic growth averages just under 4% a year for the next five years, figures not seen in this recovery so far and much higher than consensus economic opinion. The balance of the revenue increase, $509 billion, would presumably emerge from the personal tax hikes, which, though no small figure, still would fail to cover the additional outlays projected for entitlements.

It is, then, little wonder that for all the change implicit in this budget, the projected deficits remain historically high, averaging above $800 billion a year for the coming five years. Of course, such deficits would offer considerable relief from the almost $1.6 trillion of red ink recorded in fiscal 2011, but still, they would amount to historically high figures of about 5% of the gross domestic product (GDP). And were it not for the rather rosy economic assumptions built into this budget, the deficits would be that much larger. If, for instance, these five upcoming years were to exhibit growth comparable to the last three years and closer to consensus expectations, the deficit projections would show little decline at all over this time, remaining close to $1.5 trillion a year, even considering the tax hikes and minor revenue restraint outlined by the White House.

Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo.

About the Author

Milton Ezrati

Milton Ezrati is senior economist and market strategist for Lord Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. His latest book, Thirty Tomorrows, linking aging demographics and globalization, will appear next summer from Thomas Dunne Books of St. Martin’s Press. See more of his articles about the economy here.

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